"The 'Lucas critique' - Lucas's contribution to macroeconometric
evaluation of economic policy - has received enormous attention
and been completely incorporated in current thought. Briefly, the
'critique' implies that estimated parameters which were
previously regarded as 'structural' in econometric analysis of
economic policy actually depend on the economic policy pursued
during the estimation period (for instance, the slope of the
Phillips curve may depend on the variance of non-observed
disturbances in money demand and money supply). Hence, the
parameters may change with shifts in the policy regime. This is
not only an academic point, but also important for
economic-policy recommendations. The effects of policy regime
shifts are often completely different if the agents' expectations
adjust to the new regime than if they do not. Nowadays, it goes
without saying that the effects of changing expectations should
be taken into account when the consequences of a new policy are
assessed - for instance, a new exchange rate system, a new
monetary policy, a tax reform, or new rules for unemployment
benefits.

"When Lucas's seminal article (1976) was
published, practically all existing macroeconometric models had
behavioral functions that were in so-called reduced form; that
is, the parameters in those functions might implicitly depend on
the policy regime. If so, it is obviously problematic to use the
same parameter values to evaluate other policy regimes.
Nevertheless, the models were often used precisely in that way:
Parameters estimated under a particular policy regime were used
in simulations with other policy rules, for the purpose of
predicting the effect on crucial macroeconomic variables. With
regime-dependent parameters, the predictions could turn out to be
erroneous and misleading."

Perhaps it's useful to add a specific example here. Say that we are trying to figure out how much the Federal Reserve can boost the economy during a recession by cutting interest rates. We try to calculate a "parameter," that is, an estimate of how much cutting the interest rate will boost lending and the economy. But what if it becomes widely expected that if the economy slows, the Federal Reserve will cut interest rates? Then it could be, for example, that when the economy shows signs of slowing, everyone begins to expect lower interest rates, and slows down their borrowing immediately because they are waiting for the lower interest rates to arrive--thus bringing on the threatened recession. Or it may be that because borrowers are expecting the lower interest rates, they have already taken those lower rates into account in their planning, and thus don't need to make any change in plans when those lower interest rates arrive. The key insight is that the effects of policy depend on whether that policy is expected or unexpected--and in general how the policy interacts with expectations. The parameters for effects of policy estimated under one set of expectations may well not apply in a setting where expectations differ.

As the Nobel committee noted more than a decade ago, this general point has now been thoroughly absorbed into economics. Thus, I was intrigued to see Lucas note that the phase "Lucas critique" has become detached from its original context in a way that can make it less useful as a method of argument. Here's Lucas in the recent interview:

"My paper, "Econometric Policy Evaluation: A Critique" was written in the
early 70s. Its main content was a criticism of specific econometric
models---models that I had grown up with and had used in my own work. These
models implied an operational way of extrapolating into the future to see
what the "long run" would look like. ...
Of course every economist, then as now, knows that expectations matter
but in those days it wasn't clear how to embody this knowledge in
operational models. ... But the term "Lucas critique" has survived, long after that original
context has disappeared. It has a life of its own and means different things
to different people. Sometimes it is used like a cross you are supposed to
use to hold off vampires: Just waving it it an opponent defeats him. Too
much of this, no matter what side you are on, becomes just name calling."

Lucas offers some lively observations on dynamic stochastic general equilibrium models, differences across business cycles, and microfoundations in macroeoconomic analysis. But his closing comment in particular gave me a smile. In answer to a question about the economy being in an "unusual state," Lucas answers: "`Unusual state'? Is that what we call it when our favorite models don't
deliver what we had hoped? I would call that our usual state."